What Should You Do In A Broken Market?

| May 22, 2012 | 0 Comments

I am rarely surprised by market movement.

It’s normally a simple supply/demand equation.

But I am surprised at the repeated behavior that exists in certain time frames.

For example, short-term market indicators are currently at extreme oversold levels, similar to what we saw in early October 2011, August 2011, March 2011 and fall/summer 2010.

Does this make sense?

You see, as an old friend always says, “He who fears dangers will not perish by them.”

After a week of carnage, we’re probably set for a little bounce.

The thing is, is it trustable?

What was truly unbelievable last week was the total lack of upside. In addition, stocks sold off every day and also closed at the lows almost every day.

The result, the early dip-buyers were destroyed.

So, the lesson is simple… Respect the trend.

The investors who suffered the most last week were the ones who tried to argue with the market and kept trying to declare that a major turn was about to occur.

If you really do respect the trend, you can try to play oversold and extended markets for some sort of bounce, the key is to be extremely disciplined.  And most importantly is to make sure you have a plan for a quick escape in case the market doesn’t cooperate.

But wait, there’s more…

It makes me downright angry at times to hear some of the talking heads argue why you should be buying stocks based on valuation, the improving economy, or the fact that Europe really isn’t all that bad.

It seems they may really believe that the market is wrong to selloff.  However, fighting poor price action based on arguments like a wrong market is a recipe for disaster.

And unfortunately, many investors are swayed by that sort of talk.

So what does this all mean?

Hopefully my approach to this market has been clear.

It’s down trending.

Again, it’s no secret that we’re oversold enough that some sort of a bounce is due.

And there’s no reason why you can’t try to play for some quick bounces since markets acting like this tend to have sizable ones.   However, avoid the bottom-calling game and wait for the market to prove itself.

But the fact is, it’s going to take more than a couple of days of positive action for this market to even look stable.

One big positive for the bulls is that the mood is downright ugly and sentiment is approaching extreme levels. The number of stocks still above their 200-day simple moving average is nowhere near a real extreme.  But it is certainly something we need to keep our eye on.

Bottom line…

We have a broken market that is down trending but it is due for some sort of relief bounce.

If you are an aggressive trader, you can try to play this bounce.

Watch out for the bottom-callers who will continue to do their thing and tell you why the market is wrong to be acting this way.

So personally I would stay defensive and be selective with your trades. If you’re already holding high cash levels, some short-term opportunities may arise.

But, above all else, don’t forget to respect the trend.

Safe Trading,

Marcus Haber

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Category: Options Trading Basics

About the Author ()

Marcus Haber is the co-editor of Options Trading Research and boasts well over a decade of real-life options experience. Learning from some of the biggest names in the business, Marcus has served as an Options Strategist for a number of firms and was also appointed to the Options Advsiory Board with Pershing, a branch of the Bank of New York.